Please take a moment and make a financial contribution to TheFunded. If we have helped you, help us with resources to further grow the both the site and our entrepreneur training program, The Founder Institute.

Welcome

TheFunded.com is an online community of over 20,000 CEOs, Founders and entrepreneurs to discuss fundraising, rate and review angel investors and venture capitalists, and discuss strategies to grow a startup business. Enjoy the site, and be sure to join us at our Founder Showcase events to meet the community.

Prior to accepting capitla from any fund that will require board representation, one should be sure to spend some time doing background checks on the new boardmember(s). Find out what industry they came from (finance, technology, consulting etc.), check out the quality of their other portfolio investments, and be sure to interview CEO's of those portfolio companies to find out how the investor has contributed (or not) to the BOD. Chances are that you will be stuck with your boardmembers for some time, and it's good to know who you are getting into bed with prior to making any decisions.

Posted by
MrJames
on 2007-12-10

Aspiring entrepreneurs be warned. Venture capitalists will provide money for your idea, but they often walk away with most of the value, especially if you are not careful. Like an amateur sitting at a table of professionals, the cards are stacked against your success, so be prepared. Know the game.

Here are some anecdotal facts. There are five times as many people working in venture capital as there are CEO's that are funded each year (~16,500 vs ~3,000). The average venture funded CEO is fortunate to make 1/10th to 1/20th the return on exit as the venture capitalists. Just the legal fees on a later stage deal will run $50,000 or more per party involved, and the venture capitalists always flip the bill, directly or indirectly. Who do the lawyers work for again"

No matter how nice, no matter how fair, and no matter how genuine a venture capitalist appears, you are being out-smarted, out-lawyered, and out-maneuvered the second you sit down and ask for money. The first step in winning is to understand their motivations: (1) control, (2) risk, and (3) opportunity, in that order. Let's take a look at all three.

The entirety of a venture investment centers around control, and control takes many forms: control of the board, control of the voting, control of the investment capital, and, most importantly, control of the management. Venture capitalists are "control freaks," and the psychology of control is embedded in nearly every aspect of the deal legal structure. Assume that most financing terms, from Board meeting frequency to protective provisions have some origin in control, and analyze them as such. Ask yourself: in good times and in bad, how do these terms affect my behavior as a CEO" For example, did Google really need to have 14 Board meetings in one year... ever"

Venture capitalists are excellent at managing risk. It is assumed that at most venture investments fail, but approximately one in ten succeed. Following this simplistic logic, a venture capitalist would need to make at least $10 from every $1 invested in a success to recover from the 9 losses. Now, not every deal is a total loss, but a lot are. Complex protections are inevitably put in place. Let's look at a common scenario: a company receives $10 MM for 50% of the stock in a participating preferred with a 2x liquidation preference. The company sells for $25 MM right after the investment. How much does the founding team make" Nothing. The "50%" is legalese.

Venture capitalists are not very good at spotting opportunities, or they might have better odds than 1 in 10. However, they are very good at "managing" opportunities as a result. Here are some examples. Venture capitalists do not say "no" (for risk of losing an opportunity). They postpone meetings until you are achieving success, and they flock around markets with success stories. Ever wonder why a venture capitalist calls you out of the blue asking about your company" It's probably because a competitor is succeeding. Every wonder what "demonstrate traction" actually means" It means a nine figure IPO or liquidity event in your sector. Your dream is just potential, and you will be held on the sidelines until "the time is right" for the venture capitalists to make money.

The irony is that the venture capital behavior is largely a response to other abuses by CEO's. At this point, however, the venture capitalists have gone too far. The opportunities in building a venture funded start-up are gone for the great entrepreneurs. It simply makes more sense to go it alone.

Posted by
MedTech Expert
on 2008-01-01

Do not count on an NDA to keep your business plan out of the hands of those you would least like to see it. Early in my venture career, I believed, falsely, that this would inhibit VCs from sharing the plan. I learned the truth later, when I ran a VC funded company. My investors and those who wanted to ingratiate themselves to me would send confidential material they received directly to me for review. Some times it was to help advise them on certain technologies, and at other times, it was to provide a heads-up on competitive technologies.

Just assume that whatever you write/present will end up with someone (including large corporations) that you would least like to see it. You are better off posting it on Internet!

Posted by
Mr. Smith
on 2008-12-02

Investors in venture funds, called limited partners, are pulling out or selling their commitments to provide essential capital to the venture model, causing the "Limited Partner Shuffle." Some experts are quoted as saying as much as 10% of all private equity positions will change hands this year in hasty transactions to generate liquidity, including premium positions by top-tier institutions like Harvard. See below:

What does this mean and why is it relevant to entrepreneurs" A quick overview of venture capital will help to answer these questions.

Venture firms raise money to invest from limited partners (LPs), who are normally endowments, pension funds, insurance companies, and other institutions that manage large amounts of capital. An investment in venture capital is considered a high risk asset class with the potential for high returns. The professional consulting firms that publish guidelines for how limited partners should allocate money across asset classes generally recommend that a small portion go into venture capital, sometimes less than 1%. This small percentage still amounts to many billions of dollars per year being entrusted to venture firms by limited partners, who control trillions of dollars.

Generally speaking, a commitment to invest in a venture fund does not require the limited partner to transfer money until the venture firm makes an investment in a portfolio company. So, a $100 MM venture fund does not have $100 MM sitting in the bank. Instead, as venture firms make successive investments, they collect money from their limited partners and distribute that money to portfolio companies in rounds. To cover operating expenses, the venture firms separately collect approximately 2% of the invested capital as a management fee.

In order to ensure that each limited partner honors their obligation to provide money when needed, which is referred to as a capital call, venture funds implement onerous terms for forfeit or default. The most common default protection is to wipe out any returns from all previous invested capital. This encourages an active secondary market for limited partner positions, since it makes more sense to sell a commitment than to lose the value of the money invested to date.

Fast forward to Q4 2008, and you have the perfect storm of venture capital destruction. First, a relatively large number of limited partners, such as AIG and Lehman Brothers, are facing solvency issues, and they can no longer honor any capital calls to venture capital funds. The large scale dissolution of limited partners is something new.

Second, as the equity and debt markets have collapsed, the allocation of limited partners to venture capital has increased as a percentage. If an LP has $1 billion under management and 1%, or $10 MM, committed to venture capital and if that $1 billion suddenly becomes $500 MM, the allocation schedule of 1% stipulates that the LP now only invest $5 MM into venture capital. Many LPs have charters that strictly govern these percentages, forcing the LP to sell commitments in the secondary market to comply.

Third, many potential buyers in the secondary market have liquidity issues of their own. The purchase of a commitment requires resources to buy the asset, resources to pay for future capital calls, and resources to cover management fees at a time where the future is uncertain. The lack of liquidity and uncertainty has caused a collapse in the secondary market values, with many commitments selling for $.50 on the invested dollar or less. This in turn has encouraged limited partners that might otherwise commit to new positions in venture funds to consider purchasing discounted positions in existing funds.

Lastly, venture capital returns have been hard hit by the downturn, reducing or eliminating the ability of certain funds to get back any of the original invested capital. Portfolio company acquisitions are on hold, and the IPO market is frozen. For many limited partners, investing more money into certain venture firms is literally throwing good money after bad when cash is king.

Most venture firms worldwide are facing problems as a result of this "Limited Partner Shuffle." The best firms are distracted by helping limited partners transfer commitments. Other firms will cease making investments for some period of time, possibly forever. Still other firms will not be able to collect their management fees and go under in the next fews months. Nearly everyone will be fundraising and spending a lot less time with their portfolio companies.

Many entrepreneurs are now pitching firms without a future, wasting invaluable time. These "Walking Dead Funds" are going through the motions until the other shoe drops, forcing them out of business. Other entrepreneurs are counting on investments or participation from funds that have no ability to deliver any capital. Lastly, there are entrepreneurs with soon-to-be-insolvent firms that hold controlling preferred equity positions and Board seats, leaving a potentially deadly vacancy in governance and voting control. How do you sell when your primary shareholder is no longer around to grant approval"

As an entrepreneur in today's market, you need to understand the relative health of the investors that you deal with. Start by asking them directly about their financial resources and the state of their limited partners. Don't hesitate to ask other entrepreneurs and other funds as well. You future may depend on having good information about the solvency of investors that you deal with.

I feel like I have been suckered into starting LLC's by law firms over and over again, and here is what happens every time: (1) it costs twice as much to get all of the papers done, (2) we start growing and need to layer in complex partnership concepts for the equivalent of employee options, (3) we have to convert to a C Corporation to take any real external financing, and (4) the conversion costs twice as much as you expect since you need to transform a convoluted partnership structure into an equity structure.

Using an LLC structure for a fast growing start-up seems like a trick play to generate ten or twenty times the legal fees. My next company is going to be a corporation, starting with an S corp for preferential tax treatment and migrating to a C corp when the business starts to scale. Any other thoughts on this strategy are welcomed in the feedback.

Posted by
RichieBlueEyes
on 2007-12-16

This post isn't meant so much to learn about investors but is key to starting a company and attempting to not destroy your current relationships and your company in the process. Yes, I'm aware I'm posting this at 12:37AM on a Saturday night (I suppose I have no life so my advice here take as you wish :) ... well, in my defense my gf is sleeping beside me.

But most of us crazy entrepreneurs, myself included tend to get tunnel vision, tune out the world and forget about family and friends and hyper focus while we are in the honeymoon period with our idea (according to my GF, i'm in a relationship with my macbook more than with her - to be honest I'm not sure why she stuck by me during my last venture but that's a story for a beer, not here). So while in the honeymoon period, try to take 15 minutes a day out and kiss your gf, your wife, your mother, your dog, call a friend, LEAVE YOUR LAPTOP and go for a walk and attempt to have a semblance of a life. I'm still struggling with this issue myself but if you're a first time entrepreneur especially, make sure you have an outlet, a hobby, a hookup buddy, anything to leave your computer alone. No, a girl across the country on AIM doesn't count nor does poking random girls on facebook.

One great way to kill a company (and i've done this) is by being so focused on it, you can't see the writing on the walls where there are issues and they blow up when they didn't have too. Too much work hurts more than helps. Life is about balance.

With that said, i think all entrepreneurs (including myself) need shrinks. Now, I've been saying this for a while but I haven't gone to see one so I suppose it's far harder to do than suggest. I do need one, ya know, the frequent highs/low, tunnel vision, ADHD etc...

Maybe attached to term sheets should come a prescription for Ritalin and a weekly appointment with a shrink" (just kidding...or am i" :)

Posted by
fnazeeri
on 2009-03-08

I wrote this post on how the VC market is imploding which is not news to anyone on TheFunded, but I tried to take it a step further and talk about what it will look like post recovery. I read a great post on Seth Godin's blog about how everyone talks about the "crisis in our face" but not the "crisis in the distance." Anyway, here's a crack...let me know what you think.

Posted by
Mr. Smith
on 2008-03-14

As a funded CEO and as a careful observer of the venture market, it looks to me like a giant game of Roulette. When a new game begins, venture capitalists throw large sums of money at start-ups in a particular industry, just like throwing chips on numbers across a Roulette table. When the wheel starts spinning and the little white ball is rolling, more and more money gets thrown across companies in the chosen industry, until the table is brimming with chips and the dealer calls "no more bets." The ball lands, bouncing around for suspense, and the winners are called. As the table is cleared and a new game starts, a new industry is chosen, sometimes related and sometimes not.

This bizarre financing phenomenon makes some sense. Flooding an industry, like social networking or Web 2.0, with money helps raise industry awareness. Invested capital gets spread around between firms in an industry through licensing and other strategic deals. Venture partners learn the ropes as industry know-how and events emerge. And, covering the entire market with investments ensures that the one big winner will be venture backed. Having that winner in a VC portfolio makes up for all of the bigtime losses that the VC has racked up over the years, too.

Just reading a post about having many shareholders as a result of pitching angel groups, and it got me thinking about my own experiences. In my last company, we had two separate angel groups invested with a total of nearly 50 shareholders between the two, some shareholders with just a $25,000 total stake. This presented a tremendous headache when trying to secure shareholder approval for future rounds or a the ultimate merger. Read on for some advice.

Posted by
The Founding Member
on 2008-12-14

PUBLIC:

On Sunday, December 14th, the following presentation was delivered in Tel Aviv to 150 CEOs and VCs during the Globes "Israel Business Conference." It talks about the need to reset back to the fundamental partnership between the entrepreneur and capital in the current economic crisis. Enjoy!

Great deck Adeo. Jerry, Adeo is advancing the conversation, answers are hard for everyone to find. IMHO, unfortuanately, the problem is part of the nature of the beast, it's at the root: what kind of personalities choose to be managing angels and VC's when there are so many other ways that money could be invested? High rolling, risk taking, type A control freaks... it's about term sheets, control and returns to them, not a meaningful interest in the value that management is trying to create for society through execution. I don't know how that's going to change, but silence is not working.

3. RE: Funding Innovation: Hit The Reset Button

Posted by cscottlong
on 2008-12-14 15:42:50

I could not agree with slide 9 more about building great companies instead of billion dollar sales. For the venture capital industry to "return to it's early roots" many fundamental and social changes need to occur.

Over a 50 year span the model has changed from post-war development to absolute greed. How can our culture go from trying to build industry and jobs, to the hype that has overtaken the process to become the next billionaire? This is detrimental to our entire business culture, our global reputation, and is frankly part of the reason our economy is in such as mess.

Look at the hype that has surrounded the next big IPO. Investing is an emotional decision and a lot of people in the public markets have been bullshitted into believing false values in companies with overstated valuations.

It is one thing to promote your company and your vision as an entrepreneur, but when you get in bed with a VC to have them take an over priced minimal equity position just to take that BS valuation to the public markets, you have crossed a line.

This has happened time and time again, but no one seems to be calling anyone on it, not even the SEC because with restricted units it is legal. I suspect also because everyone is too busy trying to make quick money. I won't mention company names, as I am not trying to defame anyone but blame is a two way street here.

I believe that once this behavior began, and was reinforced, it changed the investment culture. No longer was it a good plan to invest in the entrepreneurs talent and vision to grow a great company to be proud of. Rather, it became more important to impose the investors staff to gain control specifically to hype it up and flip it. Talk about whoring ourselves out.

The NVCA has some interesting statistics. For those who are unfamiliar, venture capitalists pre-2001 saw an average rate of return of around 198.5% and typically stayed in a business for around 36 months. My point above. Today, they are seeing an average rate of return of around an 18% and are staying in companies for much longer. Mostly because they have no choice after the public caught onto the dot com BS and IPO's and acquisitions ground to a halt.

My point is this, the hype created massive rates of return and created a false economy that continues to inbreed itself. Despite the pain we all feel right now, I am hopeful the reckoning that is coming will put a halt to this behavior in favor of building great sustainable companies that we can be proud of, even if they do not help to advance the growing number of billionaires in this country.

Get back to pride of work and away from pride of wealth......

4. RE: Funding Innovation: Hit The Reset Button

Posted by The Founding Member
on 2008-12-14 15:49:03

Slides 9,10, and 11 present some recommendations for the venture market, venture capitalists, and entrepreneurs. Here are two particular points:

-- "Venture Capital" needs to return to its early roots where entrepreneurs and capital sources collaborated on building great businesses against all odds. It's not about whacky preferred equity rights, arbitrary ownership positions, or billion dollar exits. It is about building new businesses that have an impact on humanity, in my opinion (which I hope is debated).

-- Whole industries and sectors are under attack by the declining economy, and this common enemy forces competitors to collaborate in order to survive.

The original presentation was a bleak update to a talk given at Harvard less than two months ago. Since that talk, the situation has dramatically worsened for start-ups and venture, so the previous title of this talk was "The Other Shoe has Dropped."

Most CEOs and VCs now see how bad the situation is, so it is time to move the conversation onward about what can and should be done. Ideally, this will be a dialog. The post is an Open Letter, so please comment.

This slide deck lumping all Seed investments into Angel and all Seed investments as those under $1mil. This is flat out wrong. Angel investing is a geographically limited investing model where some folks with extra cash find stuff they like.

There is an entire Seed Infrastructure out there - incubators, academia, tech transfers, economic development agencies.

@goodform: You are correct. Seed investing and angel investing are separate, especially when seed is defined as "incubators, academia, tech transfers, economic development agencies."

The presentation does not address nor reference the seed model, which has unique opportunities and challenges of its own.

8. RE: Funding Innovation: Hit The Reset Button

Posted by 60ponies
on 2008-12-14 18:21:41

There is a common link between Wall Street blunder, Detroit mismanagment, VC implosion , entreprenuer anger, and just about every business disaster headline these days...greed. When it is all about "my share of the pie" the question is not IF it will fail, but when. Yes, it is time for a reset,on many, many levels. Deals can be made that put a smile on everyone one's face if we define success in terms other than those driven by greed.

9. RE: Funding Innovation: Hit The Reset Button

Posted by anonymous
on 2008-12-14 21:35:07

I appreciate the call for VCs to "build the company", a.k.a. build real value.
Now, any idea (a) if they agree and (b) when VCs actually start trying to build some companies?

10. RE: Funding Innovation: Hit The Reset Button

Posted by The Founding Member
on 2008-12-14 23:25:26

@anonymous RE: VC responses to greed and building companies once again.

TheFunded is working to release a Pledge that all partner at operating venture funds will be invited to sign. In this Pledge and the firm Validation that occurs by all partner signing it, VCs will commit to treating entrepreneurs with respect and to operate with certain guidelines, like agreeing to honor confidential information.

Hopefully, enough VCs will sign to show where they stand on critical matters to entrepreneurs, and, if they break the Pledge as determined by Member feedback, they will lose their Validated status.

11. RE: Funding Innovation: Hit The Reset Button

Posted by rhood
on 2008-12-14 23:33:22

Can someone tell me what the chart junk on slide #5 even means?

12. RE: Funding Innovation: Hit The Reset Button

Posted by The Founding Member
on 2008-12-15 00:30:21

@rhood: Slide 5 shows the various countries that venture capitalists operating in the Unites States believe to have "high quality" dealflow from a survey conducted by the EE Times.

There are many articles about well funded US venture firms are looking to expand the model by opening regional offices or satellite branches. The goal is to find "better opportunities" abroad, like ICQ, Skype and MySQL. Keep in min mind that the talk was given overseas in Israel.

The problem is that exporting a broken model and hoping that the nascent market characteristics of your target geography will bring the venture capital back to the glory days is, in my opinion, a fool's errand. It'll just end up broken, too, on an accelerated timetable than it took in the United States...

I'm fundraising right now and it is absolutely brutal. I want to to tell all entrepreneurs, "Fight through this. You can raise capital." But that isn't true. You may not be able to raise capital until 2010 no matter how good your product or company is. It is not a reflection of you, just the external factors that are largely out of your control.

Survive until 2010 and position your company to take off as the next economic cycle does. These things always come back. While it is bad now, it will eventually get better. The Wall Street guys will get tired of losing money and companies will start hiring again.

I hope I am wrong. (Boy, do I hope I'm wrong.) Maybe Obama will follow through on his plan to eliminate capital gains tax on investments to startups. That would help us immensely. But I have heard nothing about that since it was mentioned during the campaign.

Posted by
fnazeeri
on 2008-06-20

There are two scenarios where convertible debt is typically used: bridge financing and angel financing. I've raised convertible debt a few times and I have to say that in most angel funding scenarios it sucks as a way to finance a startup (I think it's okay for bridge funding, but I'd avoid that too if possible). Why"